Understanding Mortgage Points

Mortgage points come in two very different categories. The first is the origination point, the second is the discount point. When applying for a mortgage, you need to know which you’re paying because they could impact not only your interest rate but your taxes. Both are a part of the closing costs, not reoccurring costs over the life of the loan.

Mortgage Points Definitions

Origination Points: 

If the lender specifies an origination point, then that means you will be paying 1% of the loan as an origination fee. That’s basically a fee that covers various costs associated with issuing the loan. It doesn’t benefit you as the buyer, it only benefits the lender.

Discount Points:

Discount points buy down the interest rate on the mortgage. Each point is the equivalent to 1% of the mortgage amount. The point is not the number before the decimal, it’s the number after the decimal. For example, when you hear the Federal Reserve is increasing the base rate by 50 points, that’s half a percent. A discount point usually reduces the mortgage rate by 0.125% to 0.25%, so if you have a mortgage rate of 5%, then paying a point would make it 4.875% or 4.75%.

Tax Implications of Points

Many of the costs of closing a mortgage are tax-deductible, but some are not. Discount points are deductible because mortgage interest is deductible. Origination points are not because they are used to pay fees. You can deduct discount points even if the seller gives you a credit for closing costs.

Monthly Savings

When interest rates are high, paying discount points can be a big money saver, but it doesn’t provide as much benefit when mortgage rates are at record lows. That’s because it might only save you a small amount monthly, but require a lot of additional cash at closing. Before paying a point, you should consider the break-even, which is the month when the point will start saving you money. If you plan to sell the home before you reach break-even, then a discount point is a waste of money.

Here’s an example with today’s rates:
The mortgage is $200,000. At 4.8%, the monthly payment would be $1049. If you pay $2000 to buy down the rate to 4.675%, the monthly payment is $1034. Your savings is $15 a month and it will take you 133 months, more than 11 years, to break even.

Use this point calculator to compare costs on the loan you’re considering. If this is your first home and you plan to stay less than 10 years, then the point probably isn’t worth it. If you plan to stay for 30 years, then it might be. Over the life of the loan, paying $2000 up-front, would save you $5400 in interest.

Mortgage points are confusing, and your lender may not make clear which point you have at first. You should also ask for the rates with no points, one point, and two points so you can decide which option is best for you. Avoid origination points if at all possible. You may not be able to, but at least be clear about what you’re paying for and what you can deduct from your taxes.

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